Retiree Health Benefits and Municipal Borrowing Costs

Abstract

U.S. public-sector employers have promised over $1 trillion in retiree health and other post-employment benefits (OPEBs) – an unfunded liability of the same order of magnitude as U.S. public pensions. We show that states with greater OPEB liabilities and lower funding ratios have higher municipal bond yields on average. The effect is stronger for states with higher health costs and OPEB plans where employers have higher exposure to the risk of rising health costs and lower ability to renegotiate the plans. Our results highlight how the contracting environment of OPEB plans shapes the risk-return profile of municipal bond investments.

Keywords: Retiree Health Insurance, Municipal Bonds, Public Finance. JEL codes: G12

JEL Classification: G12, H74, H75